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At the start of this year, all eyes were on Greece.
First, there was the drama over whether bondholders would accept large haircuts. Next, there were the elections and the failure to get a coalition agreed. Finally, there was the second election, which the anti-austerity Syriza came close to winning.
At each stage, there were claims that a Greek exit from the euro would be a disaster for the world economy. The Confederation of British Industry feared it would be like “an earthquake happening in Europe” that would hit the UK hard.
Yet now Greece has virtually vanished from the headlines. So what’s changed?
In three words: Spain and Italy. The crisis has spread to these two much bigger economies: Italy has been well described as “too big to fail, too big to save”.
With Mario Draghi claiming he’d do “whatever it takes” to save the euro, it’s easy to assume that the desire to save Spain and Italy will end up encompassing Greece too.
We’re not so sure. A Greek exit could arrive much quicker than anyone expects. The good news is that this could be just what both Greece and the wider European economy need.
Greece wants more time – but its lenders are running out of patience
To comply with the conditions of its bail-out, the Greek government is supposed to be meeting targets for cutting its debt and reforming its economy. Trouble is, these targets relied on the Greek economy recovering quickly. Needless to say, that hasn’t happened.
So now, to have any hope of meeting its targets, Athens would have to make much bigger spending cuts than it had planned. Yet this would hit growth even harder in the short-run.
Given that the latest figures show Greek unemployment has risen to a fresh record of 23.1% - more than twice the eurozone average – this is not the kind of thing that voters will put up with. So the Greek government has demanded more time – two years more, in fact - to meet the targets.
Trouble is, Greece’s creditors agreed to distribute the bail-out money in stages. This gives them the power to quickly cut off funds if Greece isn’t sticking to the terms of the deal. With credit market access all but shut, a cut-off would see Greece quickly forced to leave the single currency and default.
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Up until now, Athens has got its way. But it might have reached the end of the line this time. Although its request will be formally considered at a meeting next month, both the French and German leaders have said that they will oppose any changes. German opposition in particular runs high. Indeed, Volker Kauder, the leader of the Christian Democrats in the Bundestag, claims that an extension would be the same as giving the Greeks more money (which it is, to be fair).
A bigger clue is in the fact that the talk is now of how a Greek exit can best be handled, rather than prevented. The FT reports, for example, that the German finance ministry has been meeting for some time to plan a response. If Berlin was desperate to keep Greece in, it wouldn’t be holding such meeting, let alone leaking its existence to the media.
Greece could be the tipping point for the eurozone
This may seem rather downbeat. However, Greece leaving the euro would in fact be a good thing in the long run, for both the country and the eurozone. Returning to the drachma would - after the initial shock - allow the Greeks to boost their struggling economy.
The currency would slide, increasing exports and tourism, while inflation would surge. This would reduce wages in real terms, and make Greece competitive with the rest of Europe. Inflation, and a managed default, would also reduce the debt burden to a more manageable level.
It would also be the catalyst for change that the European Central Bank (ECB) needs. While the ECB has signalled that it may consider some money printing, pushing the plans past opposition from Germany isn’t easy.
A Greek exit would force it to be much more bold. To prevent an outright collapse in the eurozone, it would have to print money to cap bond yields on the larger economies that are in trouble – such as Spain and Italy, not to mention Portugal.
Indeed, a cynic might suggest that a Greek exit would allow German opponents of such money printing to save face, and allow QE to begin. This is because they could say that the worst offender had been forced out of the eurozone, satisfying their concerns about ‘moral hazard’.
As far as investors are concerned, any money-printing by the ECB would be great news for beaten-down European stocks in particular. That’s why we’ve been tipping them regularly in MoneyWeek magazine recently. For our latest view on which European markets you should buy now, see this story: Why I'm buying Italian stocks.
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Matthew Partridge
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